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How Do Marginal Tax Rates Work?

Come tax season, there’s a question we all want to know: How much will I have to pay in taxes, and how will that affect my income afterward? Good questions, with some not-so-easy answers. The key to understanding how this works is to grasp a component of the tax code known as the marginal tax rate.

Marginal Tax Rates: What You Need To Know

In essence, marginal tax rates are the tax bracket in which you fall, as determined by your income level. For individuals, the caps are set separately than for couples who are filing jointly (see rates below). Not that you (and your spouse, if married) are taxed on your gross income, not your net income. This means the Internal Revenue Service will calculate your taxes based on what you earned before payroll taxes, garnishments, retirement plan contributions and other deductions are taken out.

It’s important to understand what the marginal tax rates are so you’re not confused or blindsided come tax season, especially if a job change or pay raise significantly alters what you’re paying in taxes. However, as we’ll address in a moment, this won’t change your income as much as you might think.

What Are the Marginal Tax Rates?

First, it’s important to understand that tax rates change every year, so you can’t depend on them staying the same from one season to the next. As an example, according to The Tax Foundation, the tax brackets for an individual filing in 2017 are:

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  • 10% Bracket: $0 to $9,275
  • 15% Bracket: $9,275 to $37,650
  • 25% Bracket: $37,650 to $91,150
  • 28% Bracket: $91,150 to $190,150
  • 33% Bracket: $190,150 to $413,350
  • 35% Bracket: $413,350 to $415,050
  • 39.6% Bracket: $415,050+

For a married couple filing in 2017, the rates are:

  • 10% Bracket: $0 to $18,650
  • 15% Bracket: $18,650 to $75,900
  • 25% Bracket: $75,900 to $153,100
  • 28% Bracket: $153,100 to $233,350
  • 33% Bracket: $233,350 to $416,700
  • 35% Bracket: $416,700 to $470,700
  • 39.60% Bracket: $470,700+

As said, these change every year, which is why it’s important to stay updated on the marginal tax rate. The new rates for 2018 can be found here, and you can check the IRS website every year for new rates. You can also ask a professional tax preparer or accountant to complete your return for you (and unless you are a W2 worker with no extra income to report, you probably should).

Does Being in a Higher Tax Bracket Cause Your Overall Income to Drop?

Does Being in a Higher Tax Bracket Cause Your Overall Income to Drop? | How Do Marginal Tax Rates Work?

Many people are concerned that moving to a higher tax bracket might mean they’d make less income overall. But, as Investopedia points out, if this were true we would all be afraid to take incremental raises, and we know that’s not how the world works. So how does the marginal tax rate account for this?

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In a nutshell, your earnings are taxed at different rates. The first $9,725 (in 2017) is taxed at the 10% rate, whereas the additional money you earn up to $37,650 is taxed at 15%, and so on. That means each phase of your income is taxed at the tax bracket you would be in if that was all you made, so your taxes don’t balloon simply because you make more money.

Plus, you always have exemptions, and these can significantly reduce your taxes along the way. Depending on the number of exemptions you have, you might lower your effective tax rate or the rate you actually end up being taxed at by a huge percentage. For instance, your income might put you at the individual rate of 25% for income earned over $37,650, but because of deductions, your overall effective tax rate ends up being around 12% total.

Time for Help?

Confused? That’s understandable, especially considering there’s an industry of tax preparers and CPAs dedicated to unwinding the incredibly complex tax code and helping you understand what the heck to do about it. The best bet is to talk to a professional who can help you sort out the rules and file the right forms to get you the best possible tax breaks and preserve as much of your income as possible.

Learn about the difference between average and marginal tax rates in this video from TheWyvern66:

However, it’s still important to understand concepts such as the marginal tax rate. This will make it easier to plan for the taxes you’ll pay come filing season as well as simplify your talks with your accountant or preparer. Go forth and conquer!

Have you fallen under the marginal tax rate bracket? What are the benefits? Please share us your experience by leaving your comments below.

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